Since then, the European Central Bank has flooded the banking system with cheap three-year money to avert a credit crunch. At the time, the U.S.-based ratings agency said it could also downgrade the euro zone's current bailout fund, the EFSF.

Downgrade Looms for Europe

Stocks slide on reports of an S&P downgrade on euro zone nations. Insight on how will this impact your portfolio, with David Donabedian, Atlantic Trust CIO.

"The consequence (if France is downgraded) is that the EFSF cannot keep its triple-A rating," said Commerzbank chief economist Joerg Kraemer.

"That may irritate markets in the short term but wouldn't be a big problem in a world where the U.S. and Japan also don't have a triple-A rating anymore. Triple-A is a dying species," he said.

A spokesperson for S&P in Paris declined to comment on the reports.

John Wraith, Fixed Income Strategist at Bank of America Merrill Lynch told CNBC the confirmation of a mass downgrade would be another serious step in the crisis and would lead to a serious worsening of sentiment.

"To a large degree it’s widely anticipated," Wraith said. "However, we think the reality of it is going to have a knock-on, ongoing impact on these markets."

“It clearly deteriorates still further the credit worthiness of a lot of the European banks and just keeps that negative feedback loop between struggling banks and the sovereigns that may have to support them if things go from bad to worse in full force,” Wraith added.

A downgrade could automatically require some investment funds to sell bonds of affected states, making those countries' borrowing costs rise still further.

"It's been priced in for several weeks, but the market had been lulled into complacency over the holidays, and the new year began with a bounce in risk appetite, thanks partly to a good Spanish auction," said Samarjit Shankar, Director Of Global Fx Strategy at BNY Mellon in Boston.

"But the Italian auction brought us back to earth and now we face the spectre of further downgrades."

Italy's three-year debt costs fell below 5 percent on Friday but its first bond sale of the year failed to match the success of a Spanish auction the previous day, reflecting the heavy refinancing load Rome faces over the next three months.